The requirement to post collateral on non-centrally cleared derivatives was a
logical final step in the global effort
to reduce systemic risk in the over-the-counter derivatives market.

As a large chunk of contracts are
too complex and not sufficiently
standardised for central counterparty clearing, mandatory margin
requirements should ensure there
is still sufficient collateral available
to offset losses in the event of a
counterparty default.

But like much of the post-crisis
reform programme, implementation has proved to be complex,
divisive and, at times, chaotic. Even
the largest dealers struggled to
meet a deadline last September for
the exchange of margin in the US,
Japan and Canada, despite having
been closely involved in the evolution of the new framework. On 1
March, a much larger pool of sell-side and buy-side participants was
due to begin exchanging variation
margin, marking the second phase
in the roll-out of the rules.

“There are many buy-side firmsthat may never have had to ex-change margin before, so they havehad to put the documentation andinfrastructure in place very quicklyor face being shut off from certaindealers, which could threaten theirability to achieve best execution,”says John Southgate, head ofderivatives and collateral prod-uct management for Europe, theMiddle East and Africa at NorthernTrust.

Recognising the scale of the transition to this new regime, regulators set a four-year phase-in for the
exchange of initial margin, which
is intended to cover any losses
between the point a counterparty
defaults and the close-out of the
trade. This phased implementation
meant only those dealers with the
largest volumes of non-cleared derivatives on their books had to post
collateral in the first wave.

Major criticism

However, for variation margin,
which covers mark-to-market
changes in the value of a contract,
regulators controversially opted
for a ‘big bang’ approach, in which
almost all in-scope entities would
have to comply on 1 March. The
lack of a phased implementation
for variation margin has been
roundly criticised, given the operational and legal complexity of
posting collateral. On 7 February, a
group of six industry bodies wrote
to regulators to request forbearance after the deadline.

It is not so much that postingcollateral is an entirely new pro-cess. Many firms already exchangemargin on a voluntary basis andlegal documentation in the form ofa credit support annex (CSA) hashistorically set out the terms underwhich collateral is to be trans-ferred. But the new framework setsstringent requirements on whatassets can be posted as collateral,as well as how and when thoseassets should be exchanged with acounterparty.

Faced with a single implementation date and little time to
prepare, the new requirements put
extraordinary pressure on legal
resources in the lead-up to the
March deadline, as CSAs had to be
either drawn up for the first time
or re-drafted to reflect the new
legal requirements.

“The scale of this project has
been enormous, as the vast majority of market participants became
subject to the rules at the same
time. Operationally, every single
in-scope party and the parties that
trade with them needed to understand whether the rules applied
to them and their counterparties
and determine what changes were
needed to their bilaterally negotiated CSAs,” says Tara Kruse, head of
the non-cleared margin initiative at
the International Swaps and Derivatives Association (ISDA).

ISDA has published a suite of
margin-compliant documentation
and other tools to help firms with
their compliance efforts, but making the necessary changes to documentation still required significant
legal and compliance resource at
each firm. In the run-up to the
deadline, market participants
began expressing concerns that
many firms wouldn’t be ready in
time, leaving them unable to trade
without regulatory forbearance.

Documentation challenges

“Dealers had thousands of CSAs to
amend at the start of this year and
some level of prioritisation may
have been necessary prior to the
March deadline. That means that
small clients at the tail end that

“When it comes to cross-border trades, the devilis in the detail and firms are having to considerthe rules very carefully.”